The equity and bond markets took a sizable hit today as bond yields soared. The Ten Year Treasury Note increase 13bps, its largest jump in 3 years (Since 5/7/2004). The equity markets followed suit by declining nearly 2%. Recent history suggests even further losses in the equity markets may be coming.

It was just twelve months ago that equity markets were in the midst of a 7% correction. The impetus for this correction was rising bond yields. Yields bottomed out in January of 2006 at 4.39% and gradually climbed until they reached 5.19% (0.80%) in mid-May. Coincidently, equities started their correction in early May and it lasted through early July.

Currently, Ten Year Treasuries have experienced an increase from 4.5% in March to close out today at 5.1% (0.60%). Including today’s nearly 2% drop, the S&P is just 3% off its YTD (and all-time) high.

It seems that the market is finally coming to the painful conclusion that the Fed is handcuffed and will not be able to lower rates this year due to increasing inflationary pressures. Rising energy and food prices are certainly not making the Fed’s job any easier. Energy and food prices are both up over 15% YTD according to the CRB Index.

I have maintained for some time that the next bear market will be defined by stagflation – a state of above average inflation and below average economic growth. The second cyclical correction of the last two secular bear markets (’37 & ’73) were both inflationary and it is looking like it will NOT be different this time .

In addition to the steep decline in bond prices (and corresponding increase in yields) the technical strength of the market is getting sloppy. Today, the number of declining stocks on the NYSE outnumbered the advancing stocks 11:1. Even with stocks less than 3% off their 52 week highs, more than twice as many issues on the NYSE hit 52 week lows as did 52 week highs (and at one point during the day, the S&P was less than 1.5% off its all time high). Market leadership has been neutral at best recently and today’s action should push the technical indicators that I track closer to being bearish.

With all that said, The S&P and DJI are only 3% off their all time highs. Market tops take time to develop. This could just be a simple correction. I’ll keep a keen eye on the technical strength of the market to determine if this indeed the beginning of the next bear market or just another head fake.

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This entry was posted on Thursday, June 7th, 2007 at 3:49 pm. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.